Financial Accounting

Financial Accounting Greg Gleeson, CPA, CFA Chief Operating Officer- GROW Partners, LLC ggleeson@growpartnersllc.com

How to think like an accountant …(esp around Valentine’s Day)

Why Important? • Financial Health of Company • Track record of Management • Independently Audited & Objective • Ease of Comparison Across Companies • Valuation of Company • Starting point for all Financial Analysis

Why Limited? • Backward Looking • Highly Summarized • Accrual Basis • Non Cash Items (“Stock Options”) • Subjective “One-Time” Charges • Accounting Elections can Make Comparisons Difficult

Do you need CPAto Review and Understand Financial Statements? • Financial Data Providers have Distilled (Bloomberg, Factset, Reuters) many important facts • Financial Ratios provide important information and details, without having to read financials themselves • There are many people analysts out who do this for you …however… • Strong fundamental research requires in-depth review/knowledge of accounting • Ability to review/examine/digest financial statements is a growing area of need in money management (e.g., forensic accounting research, fraud specialization)

Financial Statement Components • Auditors Report • Must read, if other than Unqualified, look out! • Balance Sheet • The net worth of the company at a point in time • Income Statement • The Results of Operations for a Period of Time (Accrual Basis) • Statement of Cash Flows • Operations on a Cash Basis, plus other changes in Cash • Statement of Changes in Equity & Retained Earnings • Did Company Issue Equity/Debt, at what Price? • Footnotes • Must read, the only color in the report (which is Audited)

Auditors Report • Auditors Report: • Was an audit even done? • Audit is different from an compilation, examination/attestation, agreed upon procedures, or other reports • Who are the auditors? • Are they national/reputable? PCAOB? • Was it prepared in accordance with GAAP? • Is the report unqualified (i.e., Clean) • Is the report Qualified • Why? Read very carefully! • Has the firm changed audit firms in recent years? Why?

Financial Account Review- Balance Sheet • Assets • Is it a company spinning or cash or burning cash? • Is it a company that is capitally intensive? • Is it a company that holds inventory? How old is inventory? Accounting? • Is it a company that holds intangibles • Liabilities • Can the company pay their bills? • Does the company have long term debt? Interest rate sensitive? • Does the company have unionize labor? Long term liabilities? • Are their contingencies on the books? Why? • Equity • Who bought equity at what price? • Are the senior equity or debt holders ahead of you? • Why is company raising Capital? • Can the Company Pay a Dividend?

Financial Account Review- Balance Sheet

Financial Account Review- Income Statement • Revenues • What is the revenue recognition policy? • How do they collect their revenues? • Does the company offer terms “Accounts Receivable”? • How does company account for “Cost-of-Goods Sold”? LIFO/FIFO? • Expenses • What is in G&A? Is it tight-ship? • What are cash versus non-cash expenses (such as depreciation)? • How levered is the business model? • Other (One-time) • Why does the company have one-time charges? • Are “one-time” charges routine at this company?

Financial Account Review- Income Statement

Financial Account Review- Statement of Cash Flows • Cash Flow From Operations • Translates Accrual Basis to Cash Basis • Eliminates “Non Cash” items such as depreciation, unrealized gains or losses • Gives a better estimate of what the company is generating on operating basis • Cash Flow from Investing Activities • Accounts for “big ticket” items that are typically capitalized • Shows you what the company is really spending on equipment and long lived items • Gives you an idea of how successful the company is at selling equipment • Cash From Financing Activities • Shows the sources of capital raising activities during the period • Shows distributions to shareholders

Statement of Changes in Equity & Retained Earning: • Drills down the equity section of the balance sheet • Shows the net income that made it to shareholders • Show new issuances of stock, amounts, and price • Shows retirement of stock, amounts, and price • Shows distribution of earnings to shareholders • Shows conversions of debt to equity

Footnotes: Devil’s in the Details… • “Minimum” color required by GAAP • Audited • Provides critical information to understand financial statements such as: • Earnings-per-share • Details of taxes provisions • Details of pension obligations • Valuation of Investments such as derivatives • Off balance sheet items, contingencies

Ratios: Accounting Shorthand • Reader’s Digest of Financial Statements • Objective view • Allows for Quick Comparisons against prior periods and Peers • Allows Stock Pickers to Screen Companies quickly • Widely Used Ratios can Measure Many Dimensions of Financial Reporting: • Valuation: P/E, P/S, P/B • Profitability: Margin %, ROA, ROE • Efficiency: Rev/Employee; A/R Turnover • Liquidity: Current Ratio, Quick Ratio • Credit: Debt/Equity; Debt/Earnings

Case Study: Cisco (CSCO)

Case Study: Cisco - Balance Sheet Almost $49B in Cash Low A/R Finance Rec (leases) Purchased Companies in past Took cash, haven’t booked revs 25% of company leveraged Cumulatively, have been profitable Has healthy equity

Case Study: Cisco – Income Stmt Grew 12% over past 3 years Grew 24% over past 3 years Grew 10% over past 3 years Grew 10% over past 3 years Grew 3.5% over past 3 years

Case Study: Cisco – Stmt of Cash Flow Collecting faster than in past More profitable than P&L Shows Stopped buying companies Slowed down purchasing their own stock Increasing dividend

Case Study: Cisco – Footnotes (40 pages worth) Leases grew by 9.5% in 1 year Past Due increased by 43% in 1 year

Case Study: Cisco – Ratios

CSCO--- Should you buy, sell, hold??

Financial Accounting